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Reader's Digest under fire

by Richard Morgan | Published February 3, 2012 at 4:40 PM

A year ago, during the fourth-quarter earnings call for Reader's Digest Association Inc., then-president and CEO Mary Berner had lots to report. Ebitda of $175 million for calendar 2010 had come in at the high end of guidance, as had free cash flow of $86 million. And though RDA's sales had declined 15%, to $1.7 billion, Berner happily noted that "new revenue initiatives are gaining traction." She even hinted at the bigger role licensing would play in a company already eons beyond the pocket-sized magazine that was once its mainstay. "It is clear to us that some of our key competitive advantages -- our direct marketing skills, database analytics, and sweepstakes expertise -- can easily be adapted to the sale of new products and services to supplement or replace our traditional offering," she told analysts on the call.

Berner further reported that Moody's Investors Service, on reaffirming RDA's B1 debt rating, "complimented us on our work in modernizing our corporate culture." She considered the rating agency's call-out especially satisfying in that it not only acknowledged the company's physical move into Manhattan from Chappaqua, N.Y., where for the better part of seven decades RDA's primary residence seemed more a sleepy campus than a global headquarters, but also signified "a much broader, deliberate and ongoing initiative." Not a bad start for a company barely a year out of bankruptcy. And, based on how Berner ended her prepared remarks, not a bad outlook either. "Although we have not yet reached an inflection point in terms of revenue trends," she said, "we are definitely on track to achieve improved results in 2011 and revenue and profit growth in 2012."

It was, sadly, not to be. Within eight weeks of the earnings call, Berner herself was gone from RDA, having outlasted the board once so solidly behind her by just a week. Meanwhile, the cost-saving maneuvers that had pared the company to the bone before surrendering to bankruptcy returned with a vengeance and displaced many of the revenue enhancers subsequently under way. The company's new directors and leadership, essentially the handiwork of three hedge fund managers in their early 30s, instinctively grasped the change in mandate: from investing in the company to stripping it of noncore assets and, maybe, core assets as well. RDA's new board agreed to sell Every Day with Rachael Ray in October and Allrecipes.com in January. Expected to follow these high-profile brands out the door, as soon as buyers can be found, are Weekly Reader and the Time Life licensee business acquired by RDA in 2007.

Not that selling off RDA's assets is a bad strategy. Allrecipes, in particular, commanded a so-called Internet multiple of 6 times sales. But the $175 million fetched by the digital food site still fell short of the $300 million-plus that RDA's hedgie overseers had been anticipating when they forced a regime change at the company 10 months ago. Moreover, rather than work magic on RDA's privately traded stock, the asset sales have had the opposite effect: What was assigned a value of $17.42 per share on the company's emergence from bankruptcy in February 2010 continues to descend from a peak of $35 achieved under Berner. Even Allrecipes' inflated sales price failed to excite. Several investors in RDA report its stock price has been relatively static in a range one describes as mid-single digits.

And while RDA stock is very thinly traded, potentially obscuring a fair and accurate valuation, this same investor says: "You'd be hard-pressed at this point to find anyone who disagrees with the notion that the company's takeover was a very precipitous act, including, I suspect, the hedge funds that did it."

In 2010, the year RDA came out of bankruptcy, 31 corporations filed bylaws with the Securities and Exchange Commission containing the phrase "any director or the entire board may be removed, with or without cause." Not all of those corporations completed the sentence with the exact language employed by RDA -- "at any time by the holders of a majority of the shares then entitled to vote" -- but virtually every case contained words to that effect. In only one case, however, was the bylaw used to oust an entire sitting board without so much as a proxy fight or even a special meeting. That this case is RDA has everything to do with circumstances particular to the company both pre- and post-bankruptcy.

RDA wasn't the only publishing company to restructure during the liquidity crisis, but it was certainly among the largest. A $2.4 billion leveraged buyout announced in November 2006 would put the once-august institution in the hands of Ripplewood Holdings LLC, a New York private equity firm, and saddle it with $2.2 billion in debt. In March 2007, on the occasion of completing the take-private transaction, Ripplewood introduced Berner as RDA's new president and CEO. These were the same titles she held at Fairchild Publications Inc. from 1999 to 2006, only to rise to group president when Fairchild became a division of Condé Nast Publications Inc. A magazine veteran, with earlier stints at Glamour, TV Guide and Working Woman, Berner was named Advertising Age's Publishing Executive of the Year in 2004. Yet not even she could keep debt-laden RDA afloat during the worst advertising downturn since the Great Depression.

In August 2009, after a series of credit-rating downgrades, Ripplewood had RDA file for Chapter 11 protection. And while it was sad for those who could recall the Reader's Digest of yore -- when it was run by beneficent founders DeWitt and Lila Wallace, known for giving free turkeys to staff at Thanksgiving, spontaneous distributions of cash throughout the year and a corporate art collection encompassing Monet, Renoir and Picas-so -- it was also salutary.

RDA emerged six months later in fighting trim, with a debt load lightened by 76%, to $525 million, and a leverage ratio lowered to a manageable 3 times Ebitda. Its enterprise value of $1 billion, nearly 60% less than the amount Ripplewood shelled out for RDA three years earlier, included $480 million in equity.

At the end of September 2010, in its first post-bankruptcy filing to identify principal holders of that equity, RDA listed seven that owned more than 5%. Of those, two were former creditors, J.P. Morgan Chase & Co. (with 10.9%) and Bank of America Corp. (with 6.1%), while another had been part of Ripplewood's investment group, GoldenTree Asset Management LP (with 16.7%). The last of the seven to be listed, Luxor Capital Partners LP (with 5.1%), provides the first sighting of a hedge fund that would later stage the insurrection. Over the next half-year, as banks and others sold off RDA equity often obtained by virtue of having been pre-bankruptcy creditors, Luxor would be joined by five other hedge funds: Alden Global Capital, Blackwell Partners LLC, Gam Equity Six Inc., OC 19 Master Fund LP and Point Lobos Capital LLC.

Collectively, not to mention quietly, the five newcomers and Luxor built their stake to account for 31.6% of RDA's voting shares. Then, having obtained sufficient "written consents" from other shareholders to form the majority necessary to replace RDA's board, the six hedgies gave notice of their intention to do just that on April 18. On learning of this intention, according to sources close enough to know, RDA's sitting board and management were surprised, stunned and saddened. Yet a meeting with lawyers convinced them they could not prevail. So it was that seven RDA directors, including board chairman and former CBS Corp. chief financial officer Fredric Reynolds, stepped aside. The only survivor was Berner, who also served RDA as president and CEO, but who only a week later would be replaced both on the board and in the executive suite by then-CFO Tom Williams.

Among the eight replacement directors put up by the hedgies were two commonly known to be part of the trio leading the coup: Heath Freeman of Alden and Ryan Schaper of Point Lobos. Freeman has since resigned from the board for reasons not fully understood: Some attribute the resignation to his employer's disappointment with the investment; others believe he doesn't want to be tied down by SEC restrictions on stock sales by directors and other insiders. (The former brother-in-law of his fund's founder remains an RDA director, however.) The third ringleader, Jonathan Green of Luxor, wasn't officially placed on the board but attends its meetings as a designated observer.

As individuals, RDA's instigators appear to be of wildly varying temperament. Sources who have observed them characterize one as being as sweet as can be, and another as arrogant beyond belief. Such distinctions nonetheless fell by the wayside when the trio demonstrated itself to be, as one observer puts it, "a bunch of 30-year-olds who hadn't done their homework." That may not be much of an exaggeration, either, as a regulatory filing three days after the insurrection concedes the board change instigated by the trio not only triggered a default under RDA's revolving credit agreement but constituted a change of control as defined by the company's equity incentive plan.

Although RDA got its banks to waive the credit default, the change of control accelerated the vesting of 1.1 million stock options and nearly a half-million restricted stock unit awards. The result was an extra $12.4 million in compensation expense applied to the second quarter of 2011 -- a quarter in which RDA generated only $52 million in Ebitda. Critics of RDA's interlopers contend the extra expense could have been avoided had the power play been for board control instead of board dominance.

Besides, the continuity provided by the former alternative, in contrast to the loss of all institutional memory imposed by the latter, may well have benefited the board of a publishing company suddenly bereft of publishing veterans. The oversight also seems inconsistent, if not outright sloppy, with the shrewd use of such fine print in a corporate bylaw to orchestrate a coup.

One week later, on addressing who should succeed Berner as president and CEO, RDA's new hedgie overseers stumbled again. They elevated Williams from his CFO position on the assumption, presumably, that the longtime bean counter would be equally effective as an operator. By then, though, RDA had evolved into a company with more moving parts than a soap opera. Its future no longer depended on a flagship magazine of interest to grandparents the world over but, to a much greater degree, on RDA's peerless direct-marketing and database skills to sell brands either owned by the company or developed by third parties. Direct marketing's six reportable segments -- U.S., Europe, Canada, Asia-Pacific and Latin America, lifestyle and entertainment direct, and other -- accounted for nearly two-thirds of the $1.7 billion in revenue recorded by RDA for 2010.

RDA's post-bankruptcy plan called for the company's direct-marketing operations to serve as cash cows in support of growth-promising affinity clusters. One affinity cluster, food and entertaining, housed such brands as Allrecipes, Every Day with Rachael Ray and the Taste of Home lines. Another affinity, home and garden/do-it-yourself, encompassed Birds & Blooms, Country, the Family Handyman, Farm & Ranch Living and freshHome. A third comprised the so-called Reader's Digest community, home not only to the world's most widely read magazine but also to Reader's Digest-branded books, music, video websites, digital newsletters, mobile applications and special-interest publications.

Even the most gifted of operators would have difficulty overseeing such far-flung operations. But for Williams, who spent most of his career bouncing around AT&T Inc. before joining RDA in February 2009, the challenge precipitated a paralysis. Sources say few executive decisions were made, few initiatives maintained and few e-mails answered.

Despite his isolation from so many of RDA's moving parts, Williams somehow felt confident to give full-year guidance last May while presiding over his first earnings call. Ebitda would come in between $175 million and $185 million for calendar 2011, he said, while modest revenue growth would begin in 2012.

RDA followers will have to wait until full-year financials are released in mid-March to assess the accuracy of Williams' guidance, but odds are it's way off. In its update after the sale of Allrecipes, for instance, Standard & Poor's estimates full-year Ebitda for RDA "could decline by over 30%" from the $175 million the company reported last year.

Williams himself may have come to appreciate his folly. Only one earnings call later, after citing unexpected underperformance in some direct-marketing lines and unexpected challenges at Every Day with Rachael Ray, RDA called it "prudent to withdraw its previous Ebitda guidance." And only a month after that, having spent less than a half-year at the helm, RDA's president and CEO was sent packing with a $500,000 severance.

RDA did not look far for Williams' successor -- Bob Guth, former CEO of telecommunications company TelCove Inc., was already on its board, having been hedgie-installed during the corporate coup -- nor did it resist his plea to simplify. Almost immediately, as the company's third president and CEO in five months, Guth rolled out a plan for RDA to concentrate on North American publishing and international direct marketing. As he explained in November, during his first earnings call: "Combined, these businesses were more profitable in the third quarter of 2011 than during the same period 2010. This view that our core businesses are stabilizing and that they represent a strong center around which we can rally our resources is one you'll hear throughout the call today and over the next few quarters."

Guth is further simplifying matters by focusing RDA's North American publishing efforts on what he calls three master brands: Family Handyman, with a circulation of 1.1 million; Reader's Digest magazine in the U.S., 5.6 million; and Taste of Home, 3.2 million. Worth noting, too, is last year's ad-page performance of these master brands: Family Handyman, up 9.6%; Reader's Digest, up 16.9%; and Taste of Home, down 2.8%. Not a bad showing for a year in which the Association of Magazine Media has the industry's overall ad-page performance down 3.2%.

Co-branding promises to be another emphasis under Guth, who's basically borrowing a page from the playbook of Berner during her last days at RDA. The objective here will be to exploit the trust that Reader's Digest has with America's seniors in the same way AARP has been leveraging its goodwill through branded products for everything from medical supplies to long-term-care insurance. RDA got a toehold in this potentially lucrative area last May when it announced a new suite of co-branded Medicare products from Humana Inc.

And it landed again this year in a venture with Chartis Inc. aimed at providing accident-and-health, specialized property and casualty, and other insurance solutions. RDA will bring custom-created content to the collaboration and market its programs through Reader's Digest's online and offline channels.

Such projects aside, the narrower focus embraced by RDA all but ensures that asset sales will continue apace, particularly since it has eight magazine titles in the U.S. alone outside the master-brand category.

What's more, given all the asset trades Guth made during his 25-plus years in technology and telecom companies, he may be as qualified as anybody to reconfigure RDA to a simplified core. But he better move quickly in that S&P, for one, already has the company in a race against time, secular headwinds and a burdensome cost structure.

"There are significant uncertainties and limited visibility surrounding Reader's Digest's revenues and earnings prospects, given its declining businesses and ongoing restructuring requirements," says S&P credit analyst Minesh Patel.

And these could continue to surround RDA regardless of its commitment to master brands, to cost cutting and to the divestiture of all assets Guth deems noncore. They could continue to surround RDA until it demonstrates that it's unequivocally beyond what, for now anyway, can only be construed as an ill-conceived power play.

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Tags: M&A | Reader's Digest | restructuring

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Reader's Digest under fire

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